The Lean Finance Board: How to Marry Finance and Product for Early-Stage Innovation Projects (+ Excel file)

Who should read this article?

• Product people and innovators (e.g. product managers, executives, entrepreneurs).
• Finance people and investors (e.g. budget managers, executives, VCs/angels).

Why should I read this article?

To learn about a method that allows finance and product people to speak the same language, making it easier to gain financial support for worthwhile innovation, as well as making it easier to track progress for supported projects in a simple and clear way while avoiding the risk of wasting money and empowering project leaders to make dispassionately better decisions based on sound evidence.

What is this article about?

A finance option pricing model applied to the lean innovation process, all laid out in a one-page visual canvas.

What’s in it for me?

An Excel file: LeanFinanceBoard.xls, which can be used to generate the Lean Finance Board in a ready to print format and ready to be used. Download it from the link below (Section 7).

Following repeated requests from other innovators eager to figure out how I was able to successfully support new idea initiatives at a very early stage from a financial perspective, I decided to share my methodology, as encapsulated in the Lean Finance Board, and therefore have penned this article. In addition, I decided to make available an Excel file that can generate the Lean Finance Board, in a format ready to be printed and tested.

 

When I talk of “new initiatives at a very early stage”, I am referring to the innovation phase of a project, a product, a service, a feature or even a venture, without making a distinction between start-ups or large organizations. This phase basically covers the birth of a sparkling idea to the initial steps taken towards verifying the “Product–Market Fit” [1].

 

During my career, I have sat on both sides of the table (product vs finance), and I have had to face the challenge of getting a new idea initiative off the ground many times from both perspectives (innovation vs investment). Typically I found that one of the key issues was that product and finance people seemed to speak different languages and consider different issues and seek different answers – albeit, if they both has the same overall aim. For instance, maybe some of the following issues might sound familiar to you.

The financial side

• How to reduce the financial risk to invest in a new initiative at the very early-stage under conditions of uncertainty when you have only a sparkling idea, a lot of gut feeling and a load of assumptions?
• How to decide whether to invest your limited capital in new initiative A or/and B, when both have not yet found their product–market fit?
• How to avoid comparing the financial parameters of “apples” (new high-risk initiatives) with “pears” (conservative low-risk projects) without naturally choosing the second and thus killing the innovation?
• ...

The product side

• How to honestly forecast the return on investment of a new initiative under conditions of uncertainty when you are not a clairvoyant with a crystal ball?
• How much do you need to learn before discovering that the new initiative goes nowhere and needs a pivot or it is so successful and needs 10x funding?
• How to get the budget or funding to learn about an opportunity that you think so great but today is little more than a sketch on the back of a napkin?
• ...

You get the point. They are looking at the same project through different perspectives. So the key question is: How do you get the finance people and product people on the same page?

 

My past experience in the financial derivatives market helped me to figure out how best to approach this issue, and then over time, I refined my thinking to find a more scientific and structured process, which led to me creating a one-page visual canvas, which I called the Lean Finance Board.

The Lean Finance Board is an easy-to-share communication tool that allows users to track innovation progress and decrease the communication barriers between product makers and investors by supporting greater transparency and a greater understanding of the project to get everyone speaking the same language. But before jumping into the details… Do you know in finance what an option is?

 

Options, in general, are financial instruments that can be used to protect gains in a stock that has started to look shaky. They can also be used to generate steady income from an underlying asset. Think of the underlying aspect in terms of a signal that changes its value over time but it cannot be determined with certainty a priori (e.g. a blue-chip stock, an index, even the weather). Therefore, basically, an option acts as insurance.

 

Weather insurance, for instance, is similar to an option where the weather is the underlying asset. As a matter of fact, this insurance actually depends on the weather behaviour. A farmer, for instance, may accept paying for weather insurance every year to protect his investment in his crops so that he would be reimbursed (up to a set maximum defined) for any losses if the harvest is poor or in the event of a catastrophic failure following a particular weather event. However, on the flipside, the farmer will earn proportionally from well from his investment in his crops to extremely well if everything (including the weather) goes from well to extremely well. As a result, the insurance is like a “safety net” that allows the farmer to live without the constant fear of failure. Even if the return on investment of buying a weather, an health or a travel insurance is always negative, does that mean that you shouldn't buy it? Nope, of course! So, for innovation initiatives, why shouldn't you protect your investment, time and risk of failure?

Now you know the basics of options, why don’t we use this concept with our new initiatives? Therefore, we can say that an option, on the one hand, can mitigate the financial risk by protecting the financial gains, while on the other hand, it can avoid the trap of innovation paralysis.

 

1. Innovation paralysis

Investors (finance managers, VCs, etc.) are tasked with managing capital/budgets in order to obtain the maximum return from these usually limited resources. Therefore, when they are faced with the hard task of choosing where to allocate their funds and how much to allocate, they prioritize the available opportunities mainly by focusing on the financial aspects, such as the ROI (return on investment: How much money will I earn for each €/$/￡ that I invest?) and on time, such as the BEP (break-even point: How much time will I have to wait before I have all the investment back and start to earn money?).

 

Innovators (product managers, entrepreneurs, etc.) are tasked with financially sizing up the opportunities that could be generated from new ideas, but most of the time they may struggle to estimate (one could say “guess”) appropriate figures and trends under conditions of uncertainty by predicting the future in the pre-product–market fit phase.

In this context, even if safety factors could be applied to mitigate our cognitive biases, such as:

• Causation bias: whereby we assume a cause-effect relationship, believing that previous events or similar situations can somehow determine future outcomes;
• Overconfidence: whereby even experts who are 99% certain are wrong 40% of the time, e.g. consider political and sports predictors;
• Confirmation bias: whereby we love to agree with people who agree with us;
• Negativity bias: whereby we tend to give more credibility to bad news;
• ...,

two scenarios may still typically occur:

Pessimist (or conservative)

The fear of failure or a heightened consciousness regarding the lack of confidence about the guessed predictions can lead to an over-thinking status that chokes the bias for action, such that action is never taken. In this scenario, potential innovators do not expose themselves and prefer to continue their low-risk and well-known execution activities.

Optimist (or na?ve)

The confidence of experts or the optimist’s enthusiasm, coupled with polished presentations and communication skills, can over-shine the financial parameters in order to win the funding to start a new initiative. But if things go wrong, the innovators’ careers and investors’ diligence will be threatened. What do you think would then happen the next time they have to evaluate a new initiative?

Both these scenarios, albeit in the long term, can lead to innovation paralysis. Companies affected by innovation paralysis and that instead prefer to focus only on milking today’s cash cow product, can quickly end up losing ground to competitors. Rita McGrath, professor at Columbia Business School, explains in her book The End of Competitive Advantage that companies must develop the ability to rapidly and continuously adapt to the external environment by innovating, rather than becoming entrenched in their original business models by searching for increasingly unsustainable long-term competitive advantages. As competitive pressures and the rate of technological change increase, effective innovation becomes a necessity to improve an organization’s speed and differentiation from competitive alternatives, and as the margins between success and failure continue to narrow, an alternative innovation framework is needed.

Most managers and leaders are still using frameworks that were designed for a different era of business, where the purpose of strategy was to achieve a sustainable competitive advantage. For instance, consider that the original aim of MBA (Master of Business Administration) programmes was to create a management class to grow, scale and execute the business plans of the last century’s large industrial companies, and that today, many MBA programmes are still strongly focused on teaching managers how to execute and run existing companies; which albeit still makes a lot of sense if you are looking to pursue a career in an execution role in an established organization, but this does not necessarily fit with the new generation of companies and start-ups. However, many managers and leaders are using the same MBA lessons and approaches to manage new initiatives, even if the scope is completely different.

New initiatives are NOT a smaller version of an established organization!

Consequently, for new initiatives, you should instead consider using small-batch learning cycle processes, such as the Lean Start-up methodologies, to minimize the odds of failure, by shifting from a mindset forged to execute a business plan, as present in many established organizations, to a start-uppish mindset that is constantly searching for a repeatable and scalable business model that works (product–market fit).

Established organizations tend to have a lot of fact-based data and reliable information to make financial projections about the next projects to be executed; whereas new initiatives have nothing more than assumptions! How should you compare ROI, cash flow, P&L, BEP, NPV, etc. for executing initiatives (pears) vs searching ones (apples) in order to make an appropriate decisions?

 

In the following, I put forward some practical tips to reduce innovation paralysis; however, to fully overcome it you will also need a supportive culture inside the organization. The main cultural shift is related to the perception of “failure”, which for execution managers is usually unacceptable, while for innovators it needs to be accepted as part of a trial and error process of searching. As a simple analogy, babies that first try to walk, usually fall countless times and they don’t care if they look awkward, while adults would be ashamed if they often fell over while walking. Innovative established organizations most of the time dedicate small teams to new initiatives that act as start-ups in the company tasked with searching for new opportunities. Some of them also have internal innovation incubators to achieve this goal, while their core business teams will remain focused on execution by milking their current cash cow.

If you are not yet familiar with the Lean Start-up methodologies, I strongly recommend you to deepen your understanding of at least the concepts of Lean Start-up, Agile, Design Sprint and Customer Development. The illustration below highlights some differences between a new initiative and an existing one.

Figure 1. Search phase vs execution phase

2. How to practically limit the risks

From the uncertainty/money graph of Figure 1, the difference between the very early stage of a new initiative versus an existing one should be clear. The uncertainty at the very early stage is at the highest possible level. As already said, making predictions about how the future market will take to your future product at the very early stage of the product life cycle, sounds simply crazy, but then asking for money to fund an initiative relying on future financial predictions in itself actually sounds far crazier. An investment approach that is proportionate to the relative stage of the product life cycle seems far more reasonable to limit the risk.

 

In order to limit the investment risk, we use a “Call-Option” on the revenue that a market can generate. We call this the “Market Size” value. Here, the underlying asset corresponds to the money that the market will spend to buy our product, and this is the main risky value that cannot be determined with certainty a priori. Here, our cognitive bias will likely distorting the reality when we make a hypothesis on how big the market will be; however, there is a fundamental difference between betting on the market size value and providing a range of possible values that will determine the price of our “insurance” (i.e. the call-option).

 

Among many possible market size values, three of them are noteworthy (see Figure 2):

 

A) The worst-case scenario

This scenario would happen when nobody wants our product and the market size value would be equal to 0.

 

B) The best-case scenario

For the best-case scenario, we need to evaluate in economic terms the best-market size (the best revenue) and also to budget the costs needed to scale up to that best-market size, which corresponds to the scale investment (best-market investment). The best-market size is the best value possible for the underlying asset (market size) at its maturity (end of the option life).

 

C) The neutral-case scenario

The value of the underlying asset (i.e. the market size) at its maturity is equal to the “strike price” (costs of the scale investment or best-market investment) + the “premium” (the price of the option). In our context, the premium corresponds to the investment needed to cover the costs of the search phase (search investment) to find the product–market fit.

Therefore, the income would be equal to the costs (Revenue = Scale Investment + Search Investment), which means no return on investment (ROI = 0), which also means that it has reached the break-even point.

Figure 2. Market size call-option at maturity (expiration)

As can be seen in Figure 2, there is a big grey area that I have called the “Traditional Big-F Failure Zone”, which corresponds to a heavy loss zone. In fact, with the traditional approach, if we had been funded with a scale investment to grow up to the best-market size at the beginning of our initiative, but then later we realized that the market doesn’t really exist or its value is somewhere under the scale investment value, we would have suffered a proportional loss of money.

The aim of the call-option threshold is to reduce innovation paralysis by avoiding falling down into this zone and by limiting losses to the maximum level of the search investment.

 

Key question: How do we define the value of the search investment?

Before answering this question, we need to calculate the value of our insurance (call-option) today, in order to decide how much money to invest in this insurance (search investment) at this very early-stage. To determine the price of our option today, we use a popular financial computational method: the trinomial tree model.

 

The beauty of this model is that to get our pricing tree, and then our today’s expected gain, we only need four easy obtainable values (see Figure 3):

 

1)     Best-market size: an estimation of the expected revenue coming from the market in the best-case scenario.

2)     Scale investment: an estimation of the budget needed to scale up to that best-market size.

3)     Duration: an estimation of the discovery time (financially backed up by the search investment) before getting to the expiration (i.e. maturity) of our option.

4)     Frequency: the number of update reports wanted for the duration of this option.

Figure 3. The trinomial tree pricing model

Even though we know that we cannot be precise in estimating the best-market size early on or in estimating the scale investment, this is no longer a big issue like with the traditional approach, since we adopt a financial instrument that considers the condition of not getting to the best-case scenario. In fact, the trinomial tree pricing model is a probabilistic model that considers the change in price of the possible revenue coming from our market size over time.

 

Next, I report an example, I explain how to use the trinomial tree pricing method and the Excel file that does the maths, draws the tree and creates the Lean Finance Board for you.

3. An example work-through

 

Mark, a “product guy”, is evaluating a brilliant idea that could have a huge impact on the market. He does his homework and, according to his educated guesses, here are his estimations:

 

1)     Best-market size: $100M

As an expert in his industry and after his research, Mark evaluates the best-case scenario of market revenue at $100M.

 

2)     Scale investment: $10M

Mark, as an experienced manager, is very good at budgeting costs and he approximates the cost of building the product at scale as requiring a $10M investment.

 

3)     Duration: 8 months

Mark thinks that to get evidence of a product–market fit, he would need about 8 months with a team of three people: Mark, Beth (a designer) and James (an engineer).

 

4)     Frequency: 4 times

He thinks that 2 month intervals (8 months / 4) would be a good pace to make reports to the review team about the progress of this project.

 

Note: the review team consists of at least an exec and/or a finance member.

Now, Mark meets Helen, a finance manager, early on in his thought process in order to engage her to seek her views and to keep her aware of the project. Mark is smart enough to understand that the new initiative is not just his stuff, but is a common project where both the product and finance teams need to be involved. Engaging and working with Helen from the very beginning will make it easier to get her buy-in later. Think also of this approach as a lean way to make internal, for established organizations, or external, for start-ups, “customer” discovery with investors to get a validated progressive buy-in and to avoid the “Ta-dah! Moment” and then discover that nobody (e.g. the VC, Finance Dept., C-Level, etc,) buys into your idea.

 

Mark inserts the four values described above into the Excel file (which you can download from the link below of Section 7), clicks on the “Calculate” button and obtains the Lean Finance Board, ready to be printed with the following trinomial tree (see Figure 4). At the moment, Mark lets the search investment parameter be void.

Figure 4. The first version of the Lean Finance Board

 

Mark starts to discuss these values with Helen, who really appreciates the money-oriented financial model, and after some negotiation, they agree that the project seems interesting but they cannot yet dedicate a three-person team (Mark, Beth and James) for more than 6 months on this project. However, Mark does obtain the expected budget to manage the planned expenditure for the search phase. The whole financial amount to finance the search phase would be at most equal to $1M. They keep the frequency equal to 4 moments of confrontation with the review team. The search investment had been estimated to $1M.

 

Note the 10x difference between the search investment ($1M) and the scale investment ($10M). See again Figure 2 for a better visual understanding.

 

With the hypothesis of investing $1M for the search phase and considering that today the expected return had been valued $3.18M (see Figure 4), this implies that the expected ROI (return on investment) is equal to 218% today. The higher the ROI, the better. To get an ROI that makes sense the return should never be negative, thus the search investment shouldn’t overtake the “Today’s Expected Return” option value. However, having shortened the duration to 6 months, Mark and Helen have to recalculate their trinomial tree (see Figure 5) and figure out if a $1M investment for the search phase still makes sense and guarantees a return. Mark sets the search investment parameter to 1 and hits the “Calculate” button again.

Figure 5. The second version of the Lean Finance Board

 

By changing the duration from 8 months to 6 months, the today’s expected revenue option value drops down from $3.18M to $3.15M, and the expected return is now $2.15M (ROI = 215%). Now, on the Lean Finance Board, you can read the expected return values ($2.15M = $3.15M - $1M) and not the expected revenue ($3.15M), because Mark and Helen have introduced their search investment parameter ($1M). An ROI of 215% is still very good for Helen. Therefore, Mark and Helen agree about the value of the search investment.

 

Search investment: $1M

 

Today, Feb 01, Mark presents the business opportunity to the review board asking for a budget of $1M that includes the costs of Mark, Beth and James for 6 months. The board approves the initiative due to its 100x big opportunity/low-risk (= $100M/$1M) ratio at this early-stage and the today’s expected ROI of 215%. The one metric that matters here is the ROI, which is roughly equivalent to the ratio between the market size value and the required investment. As a result, the board defines the minimum success criteria that will declare if this initiative is worth pursuing when producing at scale.

 

Minimum success criteria: market size = $22M

 

This condition means that the minimum expected revenue (market size) value at maturity (in 6 months) is equal to $22M, that is 2x the total current hypothetical investment ($11M) as the sum of the scale investment ($10M) and the search investment ($1M). This success criterion corresponds to a hypothetical ROI of 100%. If this victory condition is not satisfied, this initiative will be suspended and considered worthless. On the trinomial tree, this condition is equal to an expected return of $11M = $22M (market size condition for 100% ROI) – $10M (scale investment) – $1M (search investment), as can be seen in Figure 5.

4. The progress board

 

In their first meeting, the participants completed the Lean Finance Board header, write in today’s date (Feb 01) in the first left date field, and then write some notes in the first left tree box, as can be seen in Figure 6 (point 1). Mark celebrates the beginning of this new adventure with the team. Congratulations!

 

The next day, Mark, Beth and James start their first Lean Sprint (Build-Measure-Learn) by looking for validation of their guesses about the customer-problem pair through conducting customer interviews. Invariably all beginnings are difficult, and this is also the case here, where they invalidate their original assumptions, and then conduct a lot of interviews after changing their original guesses. The needle is not moving yet, but after all, at this stage, the team is still working to learn about the jobs to be done and about the pains and the gains of their potential early adopters. They won’t move forward until they have evidence that their customers have an existing pain that they are actively trying to solve in some way. The team works hard for 3 weeks, but finally, at week 4 they are able to validate their new assumptions and they finally obtain the problem–market fit [2].

 

Mark now has a more solid vision and a better understanding about the customer-problem pair, and he now wants to size the interest to check if his original prediction has changed and if the problem is still worth solving. Mark is right in doing this; after all, if there are not enough customers that have a particular problem worth solving, why should you start a business to solve it? Hopefully, he will see that his forecasts haven't really changed. Now, the team can move on to think about a solution to solve this problem.

Figure 6. The Lean Finance Board at its maturity day

About 2 weeks later, at week 6 (Mar 08), when the board meets to verify the initiative’s progress, Mark shows the metrics coming from the customer interview validation exercise and explains what they have learned so far, and how they are moving forward. Helen, the finance manager, and the whole review board agree that there is evidence of a positive signal. Therefore, they upgrade the initiative to point 2 of Figure 6. Now the expected return for this initiative is worth $7.84M.

 

Mark and the team have been mainly involved in the prototyping phase sprints, iterating from low fidelity to high fidelity designs during the last weeks. At week 12 (Apr 19), the board meets again and Mark explains the team progress and what they have done so far. They are on the way to solving the problem but they are not there yet. Helen and the whole review board agree that they have a sort of problem–solution fit. This time, they do not promote the team’s result with flying colours because it hasn’t significantly moved the needle to warrant the time and effort the users need to invest in it and the users aren’t sticking very much with the solution yet. This is not a negative, but it’s not a positive either. They move the initiative to point 3, as can be seen in Figure 6. The expected profit barely maintains its value ($7.35M).

 

At week 14, the product team has been able to get a good match between the problem and their solution. They are now figuring out if they can efficiently and sustainably reach their target audience and convince them to buy the product. They are also getting positive results from their experiments regarding many other aspects of their business model. Some customers are starting to ask where and how they can buy the product. Good news!

 

May 31. The review board, as usual, meets to see the progress and project achievements. Mark starts to demonstrate with metrics the customer interest and excitement for buying the product. They have good evidence that there is another strong positive signal. The board “promotes the pawn” to point 4 (Figure 6). Now the chances to achieve the expected revenue value of $22M (the minimum success criteria) seems to be realistic and Mark gets approval to start selling the product (though it is far from polished) to the early adopters while continuing to make improvements.

 

From week 20 to 24, Mark continues to record strong traction. He has huge evidence now of the product–market fit. But now, he is facing another issue. While everything seems to be going in the right direction, the search investment of $1M is soon going to be finished. Mark talks immediately with Helen about this situation.

 

Jul 12 (Week 24). Today is the maturity date when the option expires. Mark presents, on the one hand, the brilliant results and the success is evident to everyone in the room, while on the other hand, Mark highlights that they are running out of money because the search funds are nearly exhausted. That’s OK. After all, the scope of the search investment was to cover the discovering phase expenditure, not the scaling one. Today, the expected return value stands at $45.23M, far over the $11M of the minimum success criterion, which clearly demonstrates the project is profitable and the initiative is worth pursuing. Everybody is very excited in the room and the board exercises the option to move forward into the scale phase. The scale investment of $10M, budgeted 6 months before, can now be approved to start the next phase.

However, Mark, Helen and the other members of the board are smarter: they don’t move immediately on. Today, they have a bigger advantage they didn’t have 6 months before: they know their market! In fact, the odds that they are making better future predictions today are far more realistic than their early ones. Now they have some real information they can rely on. Mark makes a new estimation of the revenue that could come from the market. He reviews the scale investment too. After this consideration, he realizes that:

Market size: $50M

Scale investment: $6M

The board approves the scale investment of $6M. Mark has been able to protect a $10M investment from probable waste and has been able to shrink it from $10M to $7M (Scale Investment = $6M + Search Investment = $1M) – he feels confident and aware of the market, and furthermore, he has also increased his personal credibility. Mark celebrates the results again. Good job!

 

Clap-clap. A nice little tale! But most times, it doesn’t go like this, I hear you say...

5. Killing innovation, over-financing and running out of money

For the sake of the following explanation, as can be seen in Figure 7, the Lean Finance Board is plotted with more steps to clearly highlight the green zone, which I call the “Success Zone”, and the grey zone, which I call the “Warning Zone”. They are also visible in Figure 6. But what are they?

Once the board promotes an initiative to a green block, even if afterward it will be downgraded in each of the following steps, the expected return will be always greater than or equal to the minimum success criteria at the maturity date. Once in the success zone, the option is destined for success, at least from the formal point of view.

On the contrary, if the board demotes an initiative to a grey block, even if afterward it will be upgraded with flying colours in each of the following steps, the expected return will be always less than the minimum success criteria at the maturity date. Thus, once in the warning zone, the option is not destined for success, at least from the formal point of view and according to the minimum success criteria.

Figure 7. The success zone and the warning zone on the Lean Finance Board

If things have gone particularly bad and the initiative is close to point 3 of Figure 7, it’s time to interrupt the initiative and cancel the option. In this case, the Lean Finance Board helps you to clearly visualize the big picture and the strong negative signal, helping you to avoid the pitfalls of falling blindly in love with your initiative and also helping you to make objectively bold decisions and avoid long drawn-out discussions. Nevertheless, sometimes new seeds arise from the ashes of burnt plants. If you have learned a big lesson and you are ready for a new idea (pivot), collect the remaining funds and start to rethink a new Lean Finance Board right from the beginning and with other premises and assumptions. But, be brave: kill the present initiative right now! After all, you are still saving the scale investment from being wasted, and also a part of the search investment.

 

When things start to go very bad and the initiative is near to point 4 of Figure 7, you might also be pushed to cancel the option. However, this may be too early. In this case, think and try to evaluate the learning that you have gathered so far and understand if there is room for improvement or if you have started to figure out that you are on the way to changing direction, setting a new deadline and giving the initiative a chance to invert the route before stopping it too early by killing the innovation.

 

The searching and learning phase can sometimes be very tough. You try and change many ingredients in an attempt to find the best recipe. After all, searching is not synonymous with finding. Everybody would like to invest money with an assured result. But this is not possible, and that’s where options come to the rescue. Nobody, looking for profit, would give you some money just for the sake of learning. Options help you to invest a smaller amount of money for searching today because you expect to earn bigger money tomorrow, and even if you will lose it all at the end of your discoveries, it’s an acceptable price to pay to investigate the opportunity.

If instead, your initiative is close to point 5 of Figure 7, set aside your enthusiasm and focus on the next things to do. Due to the stunning results, the temptation to ask for new funds and to start to scale immediately could be high. The premature scaling trap (remember the lean motto "Don't scale too fast!") is still always valid and evident here. Over-financing your initiative at this stage could lead to a big waste. In fact, the risk to finish into the warning zone is still too high.

But what if you are clearly in the success zone and you run out of money? There may be too much objective evidence that the initiative is performing well for you to want to stop it. This is a nice point to be at and injecting some more money to go to the next phase makes sense now. This can also be the moment when you decide to finish the current Lean Finance Board as you have enough evidence of customer validation, so you decide to move forward to the next phase with a new Lean Finance Board and new parameters. This approach should also remove the “From-Here-To-The-Moon” business plan mindset by reducing the risk of wasting money and progressively financing the initiative according to the stage. Lean financing also helps to keep a focus on things that matter in that phase and forces the team to prioritize.

If the initiative enters close to the tip of the green triangle (point 1 of Figure 7), and afterwards it finishes at the lower part, near the minimum success criteria, it signifies a very good performance at the beginning and a very bad one in the last phase. This might generate some pertinent questions:

• Why is the initiative performing so badly now?
• Is it worth pursuing even if the initiative is in the success zone?
• Is what I validated previously comparable to the last phase in terms of timing or consistency between the frequency and results? Should a weighting difference be applied between them?
• Are the metrics well set?
• ...

And then, make your decisions according to what you discover by answering these questions.

 

If the initiative enters close to the tip of the grey triangle (point 2 of Figure 7), and afterwards it finishes at the higher part, near the minimum success criteria, it means that there has been a very bad performance at the beginning and a very good one in the last phase. You should similarly ask yourself some questions:

• Is it worth pursuing even if the initiative is in the warning zone?
• Did we find something noteworthy that makes sense for changing direction (pivot) now?
• Why is the initiative performing so well now?
• ...

 

Turn your brain on!

The Lean Finance Board is a one-page visual tool that clearly tracks and shows project progress quantitatively by pointing out the expected return step-by-step. Provided that you’re being honest with yourself and your metrics, e.g. while upgrading or downgrading the initiative, using the Lean Finance Board doesn’t mean turning your brain off and just waiting for the maturity date to determine if the expected return is worth pursuing or not. Instead, it helps you to be honest with yourself and to make dispassionately better decisions and to reduce any possibly blind emotional attachment to your initiative.

6. The maths

As can be seen in Figure 3, in this section I report the maths behind the system.

Figure 8. The maths of the pricing trinomial tree

In Figure 8, S is the value of the underlying asset price, K is the strike price, i represents the time step and j the tree node for a i time step. u, d and m are the size of the moves up, down and middle. Nu, Nd and Nm are, respectively, the number of up, down and middle jumps. r is the rate of risk-free investment, σ is the volatility of the underlying asset. pu, pd and pm are the relative transition probabilities of various movements for the value of the underlying asset S to jump up, down or stay stable. In formula (4) C is the call-option payoffs at maturity time T. The backward induction formula (5) allows calculating the option price at time i discounted by one time step.

 

To calculate the trinomial tree, the following assumptions were made:

• The average return from the asset is equal to the risk-free return (standard equilibrium or “no arbitrage” condition).
• The volatility of the underlying asset is constant and the asset price follows geometric Brownian motion.
• The size of the upward jump is the reciprocal of the size of the downward jump.

7. The Excel file

Figure 9. The Excel file that generates the Lean Finance Board

The Excel file LeanFinanceBoard.xls generates the Lean Finance Board. For the sake of better understanding, as can be seen in Figure 9, the parameters in the sheet parameters were set as the ones used in the previous example (sections 3 and 4). Nevertheless, the fields also include comments to guide you when filling them in. Once you have inserted your values, click the button “Calculate”. The trinomial tree will be calculated and the Lean Finance Board will be rendered, ready to be printed.

Download the LeanFinanceBoard.xls

Note: When you open the LeanFinanceBoard.xls file, for security reasons, you are asked to enable the macros. In order to allow the execution of the code, you must enable the macros. And, your Excel needs VBA macro language support.

Tips

1)     Let the finance and product people speak the same language.

A couple of times, I have been asked: “What if we don’t use currency values?”.

This could happen if you have a multi-sided business model, where, for instance, one or more sides are measured by the time of engagement. However, for the business model to stand up it needs to earn money from at least one side; therefore, you should always be able to convert your metrics to money.

If you work in a non-profit organization and you measure your success with non-currency metrics, for instance, you can change the currency with the time of engagement, the number of uploads or downloads, etc., but, whatever you decide to use, be sure that you compare different initiatives with the same “currency”.

My personal advice is to try to convert your custom metrics to real currencies as much as possible, especially if money is to be invested. After all, money enables everybody (e.g. both the product and finance people) to speak the same language and keeps them aligned to the same goal, especially under conditions of uncertainty.

2)     Ask for time.

In many organizations, the costs of human resources will have already been budgeted. Simply asking for time and people and no-money or low-money to provide results and evidence from the market shows your commitment, your confidence in delivering results and how much you believe in this opportunity. Although it depends on your industry, in the search phase you shouldn’t need big money to make scalable/automatic activities, but just enough money to pay for some coffees, landing pages/brochures, prototypes, etc. Think rather about non-scalable and manual activities.

Generally, this approach generates less friction with the finance decision-makers and can encourage them to give the green light rather than asking for extra money, which could be more difficult to find or for them to justify at this stage. If you are an entrepreneur, this could be your personal money, your family’s or friends’ money. Keep the big money for your scale investment.

3)     Draw a line in the sand.

Define what success looks like beforehand, and know what you are going to do if your hunch is right. The key question here is: What is enough success to keep us going?

When picking a goal early on, you are just drawing a line in the sand and not carving it in stone, because you really don’t know how to define success most of the time since you’re chasing a moving target. However, it forces you (the team) to have a clear common goal. In fact, adjusting your goals and how you define your key metrics is acceptable, provided that you’re being honest with yourself. Lower the bar if necessary, but not for the sake of getting over it: that’s just cheating. Use qualitative and quantitative data to understand what value you’re creating and adjust only if the new line in the sand reflects how your customers are responding.

Picking the target number of the minimum success criteria can be extremely hard sometimes. However, in this case, your answer should come from your scale investment or your business targets. Another approach is to look at what’s normal or ideal. Knowing an industry’s baseline means you know what’s likely to happen, and you can compare yourself to it. In the absence of any other information, this is a good place to start.

Consider also that choosing a too high minimum success criteria restricts the success zone and increases the warning zone, with the associated risk threatening the innovation by declaring an initiative to be not good enough, which is probably not the case.

4)     The innovator toolbox.

As already mentioned above, if you want to spread an innovation culture, mainly inside an established organization, you should also treat your employees as intrapreneurs and help them to develop an ownership mindset.

A suggestion would be to let them dedicate a fraction of their time, 20% for instance, to their side projects/ideas. They are the founders/CEOs of this internal initiative. Maybe, they will start by pitching to other employees and convincing them to invest their side-project time into their initiative through an internal debate, which is useful to highlight the pro/cons of the idea. They will also look for internal co-founders to deliver all their potential.

You could also provide them with a prepaid card, for instance with $1000 on it, which they could be free to spend as they want (e.g. for customer interviews, landing pages, ads); trust them, don’t ask for expenditure reports, instead ask for evidence about results. The innovation toolbox (time + prepaid cards + other) that you provide to your innovators has to be seen as the search investment of the option (e.g. to discover the problem-market fit). Whoever is able to provide great results, at the very early stage, can be allowed to continue the initiative by winning a bigger “toolbox” (e.g. to discover the problem-solution fit), and so on. Be creative!

Still here?

The Lean Finance Board was born from a personal desire to find a structured and clear way to support innovation. So far, it seems to have found a number of supporters and enthusiasts, and that is the reason why I decided to write this article. Nevertheless, the Lean Finance Board is at its debut and has not been widely tested, stressed and used in many situations yet. Therefore, if you enjoyed reading this article, please support the Lean Finance Board by sharing this article, and more than this, by leaving your comments. These will help us to discover the limits and/or the improvements needed for this method.

 

All feedback is helpful. I love brutal honesty too; don’t worry – it won’t hurt my feelings!

 

Thanks

Federico

[1] Product–market fit: A definition that I like is the condition when your product satisfies a market that satisfies you.

[2] Problem–market fit: The condition when you have evidence that your customers have an existing problem that they are actively trying to solve in some way.